Past International Rescues were More Successful than Recent Ones

"it was not contagion from Thailand that made other countries vulnerable to
financial crisis. They were vulnerable because of their own home-grown problems."

The specter of the International Monetary Fund or some other international
institution riding to the "rescue" of a country in financial distress has become such
a routine event in the 1990s that, increasingly, it invites only the cursory scrutiny
that accompanies the common place. But in Under What Circumstances, Past and
Present, Have International Rescues of Countries in Financial Distress Been
Successful?
(NBER Working Paper No. 6824)
NBER Research Associates Michael Bordo and Anna Schwartz conclude that since
1973--and especially in the 1990s--rescues have presented more problems than
solutions to the effort to stabilize emerging economies.

They note that, for more than 100 years, financial rescues mainly involved
provisioning countries with "relatively small amounts of money" at "commercial
market interest rates" with the goal of "staving off" actions that could cause
currency problems "while remedial policies were put in place." By contrast, Bordo
and Schwartz point out that rescues today usually involve large amounts of money
provided at below market rates, occur after a currency crisis is already in full
bloom, and contain conditions for policy reforms that are "easily evaded."

The result, they claim, is that bailouts provide investors and countries with
an excuse to ignore the potential pitfalls of market conditions and macroeconomic
policies. Bordo and Schwartz observe that foreign lenders now often assume that
any losses on their loans will be covered by international lending agencies, while
"emerging countries may believe that they have an implicit contract with the IMF to
be saved from their own folly."

They note that recent recipients of high profile rescue packages--Mexico,
Russia, Thailand, Indonesia, and South Korea--still have failed to make changes in
fundamental problems that required the bailouts in the first place."By contrast, in
earlier times, presumably borrowers and lenders learned the hard lesson that
caution paid," the authors write.

Bordo and Schwartz dismiss as "fallacies" two of the central preconceptions
that drive 1990s style bailouts: contagion and investors' need for "a safety net."

Implicit in the notion of contagion, they write, is the flawed assumption that other
countries will be infected with a neighbor's troubles largely by virtue of proximity,
not because they share "the same problems as were present in the first country."
For example, they note that when the Thai currency, the baht, collapsed, "it was
not contagion from Thailand that made other countries vulnerable to financial crisis.
They were vulnerable because of their own home-grown problems."

As for the safety net, Bordo and Schwartz observe that the need to "cover
investors' foreign holdings, such as large investment firms, presumes that the
national welfare depends on their welfare." "It is far from clear that protection of
any sector or industry benefits the whole economy," they write.

Bordo and Schwartz believe policymakers should look to the successful (and
modest) financial rescues of the past--such as the initiatives directed at Canada in
1962 and Italy in 1964--for lessons on how to proceed in the future. They observe
that past successes demonstrate how the IMF could "rescue a monetary authority
that has a temporary liquidity problem, is adopting remedial policies, and has a good
chance of timely repayment."

"Were today's (international) monetary authorities, including the IMF, to lend
at short term at a penalty rate on good collateral that exceeds the value of the loan,
they would be following (time-honored) principles," conclude Bordo and Schwartz.
"However, in a world of deep capital markets, such as prevails today, there are few
good reasons why the private markets cannot perform this role."

- Matthew Davis

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